Australian Mining Profits Set to Rise on China

A pile of iron ore at the Fortescue Solomon iron-ore mine in Western Australia. Some of Australia’s biggest mining names are scheduled to issue their latest earnings reports this month.

Reuters

Commodity prices may have come off the boil and China’s economy cooled, but some of Australia’s biggest mining names are still powering ahead thanks to the No. 2 economy’s still-strong hunger for raw materials.

Analysts expect profits at companies like Rio Tinto PLC and Fortescue Metals Group Ltd. to have widened as they lodge their latest earnings reports this month, after Chinese imports of commodities like iron ore rocketed to record highs. For some, it will be the first time since 2011 they have posted an on-year rise in profit.

China’s growth has of course been slowing, with the economy no longer operating at full throttle. Last month, Beijing said the country’s gross domestic product grew 7.7% in 2013, matching the year-earlier rate but well below the double-digit gains it chalked up over recent decades.

Still, Australian miners have been pumping out record volumes of minerals like iron ore, used to make steel, and coal, and shipping them north on massive vessels to Asia. China’s imports of crude oil, iron ore and copper posted all-time highs for the first month of the year, after rising sharply in 2013, according to new customs data Wednesday.

While growth may be slowing, China’s economy is many times larger than it was a few years back and it still needs massive quantities of raw materials to construct houses and fuel urbanization.

Rio Tinto, the world’s second-largest iron-ore producer, will report its 2013 annual results Thursday, and is expected to post a rise in earnings after last month unveiling record iron-ore shipments for 2013. A poll of seven analysts estimated an average net profit of $7.59 billion. That compares to a loss of $2.99 billion in 2012 due to write-downs on investment.

Analysts are also forecasting the miner–which makes around 80% of its earnings from iron ore and is targeting a further expansion of its Australian operations by a quarter in the next few years–to up its full-year dividend and report strong cashflow.

Perth-based Fortescue, the world’s No. 4 iron-ore miner, is also forecast to post a positive result when it unveils its financial report next week for the six months to Dec. 31, 2013. Morgan Stanley thinks the miner will continue a rapid pay-down of debt, while lifting returns to shareholders.

UBS AG estimates a half-year net profit of $1.67 billion and a six-cent interim dividend. Fortescue posted a net profit of $478 million in the same period last year. It didn’t pay an interim dividend.

Prices for many commodities, including iron ore, have softened as China’s growth cools and supply from mines developed when prices were high come online. But that trend is counterbalanced by larger volume demand from China, which needs huge new amounts of commodities to build new skyscrapers, rail lines and airports.

The Australian government expects iron-ore exports to reach 650 million metric tons in the year through June, compared to 527 million tons the 12 months prior.

“The big surprise [for the iron-ore market] in 2013 for sure came from the demand side,” says J.P. Morgan analyst Rodolfo Angele. “China again exceeded even the more bullish expectations.”

And despite volatile global prices, some commodities still notched up a decent average over the course of last year. While iron-ore prices were 7.4% lower at the end of 2013 compared to the start of the year, they were still, on average, higher in the year than 2012. The commodity averaged $135 a ton compared to $128 a ton in 2012.

That will help bolster at least the current earnings reports for miners of the steelmaking ingredient.

In the months ahead though, the outlook could be less bright as China’s government puts the brakes on bank lending and investment. J.P. Morgan forecasts Chinese iron-ore demand to rise 5% in 2014, compared to around 10% last year. The prospect for sluggish Chinese car sales, fewer new apartment buildings and diminished appetite for gadgets could further soften commodities demand. New supply from Australian mines could push prices lower.

Rio and Fortescue, which boast some of the lowest cost operations in the world, can continue to remain profitable even if prices fall, although a sharp pullback in prices could, of course, rattle the industry and batter earnings in the year ahead.
Companies like BHP Billiton Ltd. have the advantage of being more diversified. Unlike other big mining companies, BHP derives around a third of its earnings from petroleum, which has provided a hedge against falling prices of other commodities.

Macquarie Private Wealth tips BHP, which reports its half-year earnings Tuesday, to post a net profit of $7.4 billion for the period, a jump from last year’s result of $4.2 billion.

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